The UK, China and U.S. Jobs Report

Client Talking Points

UK

The UK election was a blowout verse mainstream expectations, British Prime Minister David Cameron and his Conservative Party have claimed an outright majority in Parliament, with 330 seats out of 650, and can form a new government. It was the biggest day for the UK FTSE 100 Index on a relative basis to other European stock markets of the year. There was a huge move in the British Pound over a percent this morning as well.

CHINA

You simply can't ignore what is going on in China. The PBOC came out and effectively said they were not going to do a massive QE. Export growth was down -6% year-over-year and imports were down -16%. China's economy is slowing at an accelerating rate, Chinese brokers are trying to create rumors about stimulus and the central bank is saying don't expect QE...all this was met by a rally in the stock market.

JOBS REPORT

Total NFP was basically inline with estimates, seeing an improvement sequentially. This is not much of a surprise since last month was the lowest number we have seen since December 2013. The jobs report showed a creation of 223,000 jobs and an unemployment rate of 5.4 percent. CLICK HEREto watch the special jobs report edition of The Macro Show.

Asset Allocation

CASH

60%

US EQUITIES

4%

INTL EQUITIES

5%

COMMODITIES

0%

FIXED INCOME

29%

INTL CURRENCIES

2%

Top Long Ideas

Company

Ticker

Sector

Duration

RH

We think people are missing the magnitude of earnings growth at Restoration Hardware (RH), the sustainability of that trajectory over a long period of time, and ultimately the degree to which that will accrue to equity holders. The question is not whether the stock will go to $110 vs $120 (where we see most price targets), but whether it will get to $200 vs $300. We think the catalyst calendar looks healthy starting with the 1Q15 print set to be release in early June. Following that, RH is set to pick up the cadence of its store opening, with 4 new stores set to be open in the back half of the year. This remains our favorite name in retail.

ITB

iShares U.S. Home Construction ETF (ITB) is a great way to play our long housing call. Builder performance was choppy in the latest week alongside beta volatility and investor attempts to square the net impact to housing from rising rates and ongoing improvement in housing fundamentals. As it stands currently, rates remain a tailwind to affordability relative to last year and would require a significant, expedited increase to have a material negative impact on housing activity in the immediate/intermediate term. Elsewhere across Housing Macro, the fundamental data continued to roll in strong.

TLT

Insomuch as the April Jobs Report may prove to be a bearish catalyst for Treasury bonds, slowing growth data over the next two quarters should prove decidedly bullish. Fighting buy-side consensus on the long side of Treasury bonds been a great call thus far so we’d be booking gains and taking down our gross exposure to this asset class on the next immediate-term pop. Ultimately, we think our #LowerForLonger theme prevails, but volatility is likely to pick up in the interim.

Three for the Road

TWEET OF THE DAY

If you want the truth about the jobs numbers, start with sources who actually model them

@KeithMcCullough

QUOTE OF THE DAY

When he worked, he really worked. But when he played, he really PLAYED.

Takeaway: When we added LULU to our Best Idea's List in June of 2014 (we removed LULU from our Best Idea's List on 3/24/15) we outlined the probable outcomes resulting from Chip's activist push. Where we shook out after weighing the puts and takes was a) Chip would not get his way and b) eventually sell his stock. Chip is a brand builder, not a brand leader and he was vocal in an interview with PwC in 2014 about his displeasure his non-compete imposed restraint. The writing appears to be on the wall for his complete exit from the company now that Kit and Ace is nearing critical mass.

In our LULU Black Book in March 2015 we said that there’s $4.00 in earnings power hidden in this company, but we need the conviction that management could find it. We are still far from convinced, though the leadership on the board has proven over the past 12mnths that it is willing to separate itself from Chip. In order to justify a 30x p/e and give anyone hope of something in the $70s or $80s (presumably what you’re playing for in buying it today) we think that the company needs to completely reset its business model.

Attendance on this call is limited. Please note if you are not a Tier 1 or 2 subscriber to our Gaming, Lodging, and Leisure research there will be a fee associated with this call. Ping for more information.

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Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

CHART OF THE DAY: U.S. Economic Surprise Index

Editor's Note: This is an excerpt from today's Morning Newsletter which was written by Hedgeye Senior Macro Analyst Darius Dale. If you're ready for some dynamic market and economic insight and analysis, we encourage you to subscribe.

Since this is probably the only strategy note you’ll read this morning that doesn’t focus on the jobs report, we’ll leave you with another piece of seemingly-random-but-useful analysis. The key takeaway from the Chart of the Day below is that over the next 2-3 months, the preponderance of high-frequency growth data is likely to look optically better relative to consensus expectations from here. It literally can’t get much worse as far as the surprise factor is concerned and we’re quite sure expectations for a broad swath of indictors were lowered after that soft 1Q GDP print. Also, 2Q GDP will accelerate on a headline (i.e. QoQ SAAR) basis.

We believe rates have likely priced in these dynamics and see no reason for bond yields to chase them any higher.

Dazed and Confused

While Nurse Kenny’s boldness served her well in her treatment of polio among other musculoskeletal illnesses (her controversial methods are credited with being the foundation for modern physical therapy), I’m not so sure she would’ve been able to manage global macro risks during confusing times like these with that attitude.

For example, what if you took on orange jumpsuit risk and got the look-see on today’s jobs numbers? Would you know how to appropriately position for it? Would you be a lion and bet big on red or black or would you be a sheep?

To be crystal clear, we don’t have any edge in accurately forecasting the rate of change in nonfarm payrolls. Between the seven analysts on our macro and financials teams, we have just shy of a cumulative 100 years of experience analyzing markets and economies in both buy-side and sell-side roles and not one of us has been able to build a model that consistently and accurately forecasts said number – or the rate of change in wages for that matter. The standard error on every model we’ve built is too high to rely on such estimates so we don’t bother to incorporate them into our views.

I guess we are the sheep.

Back to the Global Macro Grind…

There is a reason our cash position in our model asset allocation is as high as it’s been since mid-December; we are dazed and confused and require the shepherding of Mr. Market. Like God, he doesn’t speak to you directly – or out loud for that matter. Fortuitously, we employ a number of rigorous quantitative methods to extract such guidance from the marketplace (like TACRM for example).

Our intermediate-term views of lower-for-longer and deflation has been wrong for several weeks now and we have no problem jettisoning such views if Mr. Market tells us to. In this regard, he hasn’t given us the signal(s) just yet, but he’s definitely thinking out loud enough for us to lack a high degree of conviction in those views.

One thing we do have a high degree of conviction on is our ability to forecast the rate of change in both growth and inflation. We are also pretty good at figuring out how trends in these omnipotent macro factors front-run changes in monetary policy.

On that front, inflation is likely to accelerate in 2H15 and the risk to that forecast is actually to the upside as far as timing is concerned. Our inflation tracker had forecasted a bottom in YoY CPI in June as of ~6 weeks ago, but we now have the disinflationary impact peaking in April (chart #1 and chart #2). You’ll note on our GIP model (chart) that the 2nd derivative delta on inflation (x-axis) is very small in 2Q. We’re still disinflating, but not by much from here.

As previously mentioned, the base effects for CPI get really easy in the 2nd half of the year (chart). Will the Fed use this as justification for “having confidence that inflation will return to their target over a reasonable timeframe” and set the stage for hikes in 1H16? Maybe. By then, however, real GDP growth will have likely slowed dramatically (chart).

Broadening our horizon, inflation is still slowing on a trending basis across the world’s key developed economies. Across many of the EM economies, however, it is accelerating due to annualized currency debasement (chart). From a forecast perspective, global inflation is in the same boat as the U.S. (chart).

The strong inflows into TIPs of late appear somewhat prescient in the context of those forecasts. Specifically, investors have piled into TIPS at the fastest pace in three years, with $3.6B of inflows into mutual funds and ETFs that track this market. This follows two consecutive years of outflows.

Can rates work when inflation is accelerating? Our backtest data shows that the long bond usually works in #Quad3, but certainly not as much as it does in #Quad4 and arguably not when the Fed is setting the table for rate hikes (chart #1 and chart #2). We are simply making the bet that those rate hikes are not coming; in fact, the narrative could be one of preparing markets for QE4 by the time we get the 4Q15 GDP report at the end of January 2016. We believe spread compression to be a high probability outcome from here (chart).

Since this is probably the only strategy note you’ll read this morning that doesn’t focus on the jobs report, we’ll leave you with another piece of seemingly-random-but-useful analysis. The key takeaway from the Chart of the Day below is that over the next 2-3 months, the preponderance of high-frequency growth data is likely to look optically better relative to consensus expectations from here. It literally can’t get much worse as far as the surprise factor is concerned and we’re quite sure expectations for a broad swath of indictors were lowered after that soft 1Q GDP print. Also, 2Q GDP will accelerate on a headline (i.e. QoQ SAAR) basis.

We believe rates have likely priced in these dynamics and see no reason for bond yields to chase them any higher.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.87-2.29%

SPX 2071-2099 VIX 13.63-15.84 USD 93.61-96.53 Oil (WTI) 54.22-61.93

Gold 1170-1214

Best of luck out there,

DD

Darius Dale

Senior Macro Analyst

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05/08/15 08:02 AM EDT

Before & After

This note was originally published
at 8am on April 24, 2015 for Hedgeye subscribers.

"It’s like Speed 2 but with a bus instead of a boat.”

-Milhouse Van Houten, The Simpsons (season 12)

Progress is generally not a cosmological crapshoot; some mystical coming together of elements, which, through some random spontaneity, have come to form a specific, organized end.

Black swans and accidental billionaires are real but success, by and large, is not an accident.

Progress and change can, at times, be illusory however.

You know those “Before” and “After” photos that grace the pages of pretty much every fitness and nutritional supplement ad you’ve ever seen? I took part in one of those photo shoots one year following a natural bodybuilding show I did.

The best part...

I did both the “BEFORE” and “AFTER” photo in the same day. No twelve-week transformation, no sophisticated supplement cocktail, no sycophantic testimonial ...mostly make-up, lighting artistry and photo editing acrobatics. Yep, the venerable before & after shot – that paragon of fitness marketing – can be (not always) the simple product of illusion and marketing malfeasance.

Back to the Global Macro Grind…

It’s been a tough last couple days for housing bulls with price volatility rising and performance whipsawing alongside company earnings and data seasonality. However, similar to my illusional instantaneous physique transformation, the ‘Before’ and ‘After’ of Housing’s underlying fundamental reality is largely unchanged.

Let’s review and contextualize the crush of recent data, starting with the (perceived) negatives.

DHI: D.R. Horton beat top and bottom line estimates for fiscal 2Q on Wednesday, reporting 30% growth in orders, strong selling season demand and a rising backlog while raising full year sales and construction estimates. The stock, however, closed down -5.4% on the day as management pared back its gross margin forecast by -50bps on account of the rising contribution from and increased focus on the lower-margin, entry level market (i.e. 1st time homebuyers).

So, investors remain acutely focused on builder margins - a preoccupation and movie we’ve seen before with KBH reporting a similar quarter, with a similar investor response, at the start of the year. To tie in today’s amusing but otherwise irrelevant headline quote - it’s like January but with DHI instead of KBH.

The bullish rejoinder to the margin concerns is two-fold:

It’s our view that the recent margin weakness is largely a product of the marked deceleration in HPI (Home Prices) that occurred over the course of 2014. In other words, it’s a product of rearview dynamics. With home price growth stabilized and now beginning to accelerate over 2015 the forward outlook for margins is improving.

DHI is making a calculated bet that 1st time homebuyer demand is poised to accelerate meaningfully and the market disagree’s with the conclusion and/or the operating decision. DHI’s own results are testament to the improving trends in entry level demand. With employment growth for the 20-34 year old group now positive for 2-years and accelerating over the last couple quarters the labor market dynamics are supportive of that expectation as well. Further, the FHA loan cost reductions and low downpayment loan programs rolled out by Fannie/Freddie in January are all aimed at bolstering entry-level demand.

We understand the margin consternation but, from a top-down perspective, it’s difficult to characterize accelerating demand as a negative fundamental development, particularly with a view that HPI should support margin improvement going forward. This is why we've been recommending buying the dips on builders - such as KBH when it traded down to $11 (24% lower from yesterday’s closing price) back in January - that sell off on margin concerns.

New Home Sales: New Home Sales for March, reported yesterday, declined -11.4% MoM to +481K. The sequential retreat was notable and captured most of the headlines but was, in fact, not overly surprising and deserves proper contextualization. New Home Sales in February were the highest since February 2008 and some 22% above the TTM average so a modest hangover on the heels of that comp should not be unexpected

Further, as we show in the Chart of the Day below, given the favorable comp dynamics, New Home Sales in March – despite the sequential softness – were still up a remarkable +19.4% YoY. Moreover, with comparison’s remaining favorable through July, year-over-year sales growth is likely to come in in the upper-teens to mid-twenties over the next four months - one would be hard pressed to find a better, rate-of-change chart in all of Global Macro.

So, DHI’s earnings were disappointing and New Homes Sales in March were soft…but not really. Moving onto this week’s discretely positive housing data….

Purchase Applications: Purchase demand, as measured by the MBA’s weekly survey, rose +5.0% week-over-week to 205.4 on the Index – the highest level since June of 2013. On a year-over-year basis, purchase demand accelerated to +15.4% - the fastest rate of growth YTD and the 15th consecutive week of positive growth. Purchase activity in 2Q15 is currently tracking +13% QoQ and +12% YoY.

Existing Home Sales: Existing Home Sales rose +6.1% MoM in March to 5.19M Units SAAR – marking the highest level in 18-months. On a year-over-year basis, EHS accelerated to +10.4% YoY as the confluence of easy comps, improving organic demand and weather related catch-up all supported the rebound in reported demand. That same constellation of factors should continue to support strong 2nd derivative improvement in demand over the next couple/few months.

FHFA HPI: the FHFA Home Price series for February released this morning showed home price growth accelerating to +5.5% YoY (vs. +5.1% prior), further corroborating the acceleration reported by the CoreLogic series earlier this month. Tight supply should continue to support home price growth and given the strong relationship between housing related equities and 2nd derivative HPI, the existent demand/supply/price dynamics should support performance across the complex.

We turned positive on Housing back in November but having been on both the long and short side of housing multiple times since 2008 as our model is both data sensitive and dynamic.

Looking forward, there are a trinity of known risks to housing activity whose likely magnitude of impact remains largely unknown. Specifically, the convergence of negative seasonal performance, new regulation (TRID) and the impacts of the California/West Coast drought pose a collective risk to housing activity into late 2Q/early 3Q.

However, while we remain mindful of those quasi-latent risks, we continue to think improving fundamentals and accelerating rates of change in both demand and price should dominate investor mindshare and related equity performance in the more immediate-term.

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